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Problem 1

A Malaysian-based shipping entity lost an entire shipload of cargo valued at


P5,000,000 on a voyage to Japan. It is however covered by an insurance policy.
According to the report of the surveyor, the amount is collectible, subject to the
deductible clause in the insurance policy. Before year-end, the shipping entity
received a letter from the insurance entity that a check was in the mail for 90% of
the claim.
The international freight forwarding entity that entrusted the shipping entity with
the delivery of the cargo overseas has filed a lawsuit for P5,000,000, claiming the
value of the cargo that was lost on high seas, and also consequential damages
of P2,000,000 resulting from the delay.
According to the legal counsel for the shipping entity, it is probable that the
shipping entity would have to pay the P5,000,000 but it is a remote possibility
that it would have to pay the additional P2,000,000 claimed by the international
freight forwarding entity, since this loss was specifically in the freight-forwarding
contract.
What provision should be recognized by the shipping entity at year-end?
a.7,000,000
b. 5,000,000
c.3,000,000
d. 0
Solution Answer b
Estimated liability for a lawsuit

5,000,000

The lawsuit claim of P5,000,000 is recognized as a provision because it is both


probable and measurable. However, the additional claim of P2,000,000 is not
recognized because it is remote.
Problem 2
On January 1, 2014, Moon Company owned a machine with cost of P2,000,000.
The accumulated depreciation was P1,200,000, estimated residual value was
P120,000 and fair value was P3,200,000. On January 5, 2014, this machine was
irreparably damaged by Sun Company and became worthless. In September
2014, a court awarded damages of P3,200,000 against Sun in favor of Moon. On
December 31, 2014, the final outcome of this case was awaiting appeal and was
therefor uncertain. However, in the opinion of Moons attorney, Suns appeal
would be denied. On December 31, 2014, what amount of gain should be
accrued?
a. 320,000
b. 120,000
c. 200,000
d. 0
Solution Answer d

The contingent asset and related contingent gain are only disclosed, because the
case is still under appeal by the defendant.
Problem 3
During 2014, Delavingne Company is the defendant in a breach of patent lawsuit.
The lawyers believe there is an 80% chance that the court will not dismiss the
case and the entity will incur outflow of benefits. If the court rules in favor of the
claimant, the lawyers believe that there is a 70% chance that the entity will be
required to pay damages of P2,500,000 and a 40% chance that the entity will be
required to pay damages of P1,000,000. Other amounts of damages are unlikely.
The court is expected to rule in late December 2015. There is no indication that
the claimant will settle out of court.
A 6% risk adjustment factor to the cash flow is considered appropriate to reflect
the uncertainties in the cash flow estimates. An appropriate discount rate is 10%
per year. The present value of 1 at 10% for one period is 0.91. What is the
measurement
of
the
provision
on
December
31,
2014?
a. 3,500,000
b. 1,823,200
c. 1,659,112
d. 0
Solution Answer c
Weighted Probabilities:
. 70 X 2,500,000 X 80
. 40 X 1,000,000 X 80
Expected cash flows
Multiply by risk adjustment factor (100% + 6%)
Adjusted cash flows
Multiply by PV of 1 at 10% for one period
Present value of cash flows

1,400,000
320,000
1,720,000
1.06
1,823,200
.91
1,659,112

Problem 4
Wolz Company sells motorcycle helmets. In 2015, the entity sold 5,000,000
helmets before discovering a significant defect in their construction. By
December 31, 2015, two lawsuits had been filed against the entity. The first
lawsuit, which the entity has little chance of winning, is expected to be settled out
of court for P3,500,000 in January 2016. The legal counsel believed that the
entity has a 50-50 chance of winning the second lawsuit, which is for P1,000,000.
What is the accrued liability on December 31, 2015 as a result of the lawsuits?
a. 3,500,000
b. 4,500,000
c. 6,000,000
d. 8,500,000
Solution Answer a
The loss on the first lawsuit is both probable and measurable and therefore can
be accrued as a provision.
The loss on the second lawsuit is disclosed as a contingent liability because the
loss is only possible.
Problem 5
Milagros Company issued the 2015 financial statements on March 1, 2016. The
following data are provided by the entity for the year ended December 31, 2015:
Amount owing to another entity for services rendered
during December 2015
Estimated cost of relocating an employee from head
office to a branch in another city (employee will
physically relocate in January 2016)
Estimated long service leave owing to employees
in respect of past services
Estimated cost of overhauling machine every 5 years
(the machine is 5 years old on December 31, 201

350,000
120,000
1,300,000
170,000

What amount should be recognized as provision on December 31, 2015?


a. 1,300,000
b. 1,420,000
c. 1,940,000
d. 1,590,000
Solution Answer a
Long term service leave

1,300,000

A provision is a present obligation that is uncertain in amount or timing. The


present obligation must be both probable and measurable.
The amount owing to another entity is a present obligation but technically it is not
a provision because the amount is certain. Of course, it is an accrued liability.
The estimated cost of relocating the employee is a future cost because it is to
be incurred in January 2016. Thus, it is not included in December 31, 2015
provision.
The estimated cost of overhaul is not a provision because there is no present
obligation. The entity may decide to sell the machine or not to repair it.

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